The booming express delivery market and its reliance on e-commerce

On October 2016, a company called ZTO Express (ZTO) went public on the New York Stock Exchange [NYSE: ZTO]. Raising $1.4 billion, ZTO marked the largest IPO by a Chinese company in the U.S. in 2016. ZTO is also the only top Chinese express delivery companies to list in the U.S.; others chose Shenzhen or HongKong.

ZTO is one of the major players in the express delivery market in China. Other key players include China EMS, SF Express, YTO Express (YTO), STO Express (STO) and Yunda. The express delivery market has consolidated over time, driving many small firms out of business.

 

1. Development of the express delivery market

The formation of China EMS in the early 1980s marked the start of China’s express delivery industry. China EMS is operated by a subsidy of China Post, the state-owned enterprise operating China’s post offices. Other aforementioned companies were founded in the 1990s and 2000s.

Global delivery giants DHL, UPS, Fedex and TNT originally entered China in the 1980s through joint ventures with domestic firms. In the mid 2000s, UPS, Fedex and TNT formed wholly-owned entities while DHL continued the joint venture. These companies own most of the international delivery market (to and from China); they were estimated to have a 75% market share in 20151.

However, their presence in domestic express delivery (intercity and intracity) in China is immaterial due to policy restrictions and price competitions from domestic firms. In fact, DHL discontinued its domestic express delivery service in China in 2011, citing fierce competition as the reason for its exit.

The top 6 firms, YTO, ZTO, STO, Yunda, SF Express and EMS capture ⅔ of the market as of 20151. While YTO, ZTO, STO and Yunda had higher volume, their businesses differ from SF Express in a few ways. SF Express owns and operates its delivery network and fleets whereas the other 4 companies have adopted a franchise model. Compared to the other 4 firms, SF Express is also more focused on business shipping and the mid to high-end of the e-commerce delivery market.

The express delivery market in China has seen robust growth. According to the State Post Bureau (SPB), from 2006 to 2015, express delivery volume increased from 1 billion pieces to 20.7 billion, representing a 40% CAGR. China has become the largest express delivery market globally measured by volume. During the same period, revenue increased from 30 billion CNY to 380 billion CNY, a CAGR of 28%. Data for the last 10 quarters shows that volume and revenue have still been growing at decent rates. Revenue per piece has declined over time, down approximately 60% from 30 CNY in 2006.

Despite enjoying rapid growth and larger market shares, domestic firms are much behind on revenue per piece. After all, international delivery is a higher revenue per piece and [likely] higher margin business. The global delivery firms charge a premium price for service and distribution network. The below chart based on SPB data illustrates this point. International companies generate ~1% of total express delivery volume but ~6% total revenue in 2016.

There is one factor playing a role in both the high volume growth and low revenue per piece in the express delivery market: e-commerce.

 

2. E-commerce has had big impact on the express delivery market

E-commerce has been a main contributor to the express delivery market growth over the past few years. For example, ZTO makes the connection when it talks about the opportunities from e-commerce in its Q2 2017 earnings.

Note the chart on the right is volume not revenue. Revenue is not growing at the same pace as intense competition puts pressure on revenue per piece, especially considering the homogeneity of many of the delivery services. Significant reliance on e-commerce weakens the express delivery companies’ negotiating power. For example, ~80% of ZTO’s parcel volume is from Alibaba. YTO also mentions deriving the majority of its revenue from e-commerce in its filings. SF Express is the least reliant on e-commerce amongst the 5 companies in the private sector.

When looking at the relationships between e-commerce companies and express delivery companies, two entities that must be discussed are Alibaba’s Cainiao Network and JD’s JD Logistics.

Cainiao Network

 Cainiao Network [菜鸟网络] (Cainiao) is a joint venture Alibaba formed in 2013 with a number of firms including investment firms and ZTO, YTO, STO, Yunda and SF Express. Cainiao does not deliver packages – it operates a logistics data platform linking its information system and those of logistics partners.

Through Cainiao, consumers, merchants and logistics service providers are linked together. The platform interfaces with a range of systems including Alibaba’s marketplace transaction systems, Alipay’s payment system, merchants’ CRM, ERP and warehouse management system and third-party transportation management systems.

This ecosystem approach enables Cainiao to add value to the entire logistics value chain with the vast amount of data it collects and/or has access to. Customers get better visibility into their orders and merchants get insights into inventory management and warehousing.

The value-add to express delivery companies is significant. Cainiao can screen out parcels that have not been delivered after 48 hours so express delivery companies can explore the reasons and have a better idea of each location’s operational efficiency. The platform also enables express delivery companies to benchmark their service levels against industry levels. In addition, Cainiao leverages data to optimize the express delivery companies’ delivery routes.

The services Cainiao provides depend on how merchants want to handle their logistics. For merchants who want to handle order fulfillment themselves, Cainiao primarily provides delivery route optimization to express delivery companies that merchants rely upon for order pickup, transportation and delivery. For merchants who want Cainiao to handle order fulfillment, Cainiao charges a fee to handle warehousing and delivery for these clients. Cainiao owns some of the warehouses (the rest are partner warehouses) but it does not handle warehouse operation – it relies on partner firms specializing on this. Similarly, it relies on the express delivery companies to do the delivery.

Cainiao’s full potential lies in the latter service model. In the prior service model, items are moved in a point-to-point fashion, usually from a merchant’s warehouse to the end customer. In the latter service model however, merchants can outsource the entire logistics process to Cainiao. Cainiao’s network of warehouses and big data capabilities lower the cost of warehousing and transportation for merchants. One example of big data application is to move goods to the warehouse closest to potential customers. By connecting the warehouse network with express delivery companies’ delivery network, Cainiao is further able to optimize the delivery route and cut down delivery time.

Essentially, Cainiao is the brain of the logistics value chain. Its network connects and leverages resources such as warehouse companies, express delivery companies and delivery personnel to build a more efficient logistics network. While it provides many value-add to the express delivery industry, it also makes the express delivery companies more reliant on Cainiao and the Alibaba ecosystem.

JD Logistics

JD started building its own logistics system in 2007. It was a bold move given JD was a much smaller company at the time and logistics cost money – warehouses, facilities, fleet, and headcount just to name a few. As of Dec 2016, JD operated 256 warehouses with 5.6 million m2 in floor area.

 In April of this year, JD formed a new business unit JD Logistics [京东物流] that will operate as an independent subsidiary. JD is certainly ambitious about the new business unit. It laid out goals such as reaching 100 billion CNY in revenue and 50 million m2 in floor area in 5 years.

Back in November 2016, JD had started opening up its logistics capability to 3rd parties including 3rd party sellers selling on the JD marketplace and merchants that do not sell on JD. JD’s goal is for JD Logistics to only derive half of its revenue from the JD marketplace in 5 years and less than 20% in 10 years. To achieve this, JD Logistics is offering integrated services and solutions to attract merchants and businesses. A merchant can outsource warehousing, transportation, delivery, customer service and after-sale service all to JD Logistics. JD Logistics also offers technology services such as logistics cloud, drones, automated warehouses, merchant sales forecast and inventory management.

Unlike Cainiao, JD holds the permit and operates an express delivery business. In an interview, Founder Richard [Qiangdong] Liu said JD Logistics differ significantly from express delivery companies. Liu believes that express delivery companies make money by making more deliveries while JD Logistics strives to improve logistics efficiency, which means fewer deliveries. This is made possible by moving goods to the closest warehouse to potential customers, similar to what Cainiao is doing. Regardless, JD’s own express delivery company can be in direct competition with other express delivery companies.

 

3. Recent clash between e-commerce and express delivery companies

Two high-profile events happened in the express delivery industry this summer: Cainiao’s data access battle with SF Express and JD’s removal of Tiantian Express from its marketplace.

Cainiao and SF Express data access battle

On June 1st, Cainiao announced that SF Express cut its data access that resulted in some merchants/customers not able to view logistics information handled by SF Express. Cainiao then recommended merchants to use other express delivery companies until the issue is resolved. SF Express responded by saying Cainiao first initiated the data access block of Fengchao [丰巢], SF Express’ self-service pickup lockers with the goal to pressure SF Express to switch from Tencent Cloud to Alibaba Cloud.

Cainiao came back and stated that it blocked Fengchao’s access for information security reasons: Fengchao did not provide the data Cainiao asked for increased security verification on deliveries deposited into Fengchao. SF again gave its version: SF Express started partnership with Cainiao in 2016 and in this year’s renewal, Cainiao asked Fengchao to give access of all parcel information to Cainiao, including those unrelated to the Alibaba marketplace. SF Express did not accept the terms and Cainiao blocked Fengchao’s data access after current partnership expired.

Fengchao is a joint venture set up in 2015 by SF Express, STO Express, ZTO Express, Yunda and GLP, a logistics facilities company with a leading market share in China. Fengchao provides self-service pickup lockers for customers to conveniently pick up and/or drop off parcels. It is worth noting that Cainiao operates a platform Cainiao Yizhan [菜鸟驿站] that provides similar pickup and dropoff services.

Interestingly, one day after Cainiao’s public announcement, JD told the press that JD had started to fully integrate with Fengchao since the end of May. After a few days of impasse, the SPB intervened and Cainiao and SF Express eventually resumed data access for each other, although it is not clear what data access is being agreed on.

JD removes Tiantian Express from its marketplace

A month after Cainiao and SF Express turned data access back on for each other, JD shocked many by removing Tiantian Express as a shipping option from its marketplace. Among them is Tiantian Express; the company said JD’s move caught them off guard and they filed complaint to the SPB.

JD seemed to have its reasons. According to the company, Tiantian Express was removed due to poor service quality and user experience. JD claimed that it had been evaluating all the third party express delivery companies internally and Tiantian Express was ranked last in the first half of 2017. Tiantian Express however, did not buy this and stated that JD never published any data or disclosed any evaluation information to them.

Tiantian Express, together with Best Inc. [NYSE: BSTI], are right behind the 6 express delivery companies mentioned earlier in terms of market share. In January, Tiantian express was purchased for 4.25 billion CNY by Suning, a large retailer in China. Suning and JD are competitors: both have top-ranked B2C capabilities and are popular places to shop for computers, home appliances and etc. Therefore, the removal of Tiantian Express can feel like a tactical move against Suning. Yet data from the SPB on 2016 express delivery companies service satisfaction survey does show that Tiantian Express ranked 2nd to last out of the 10 companies in the published results. JD also mentioned that its partnership with Tiantian Express could be restarted if Tiantian Express provides a solid plan to improve service quality.

 

(1) Based on data provided by market research and consulting firm chyxx.

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